Reason Magazine - Topics > Corporate Scandals

Sarbanes-Oxley Lawsuit Dismissed

bdoherty@reason.com (Brian Doherty) — Fri, 23 Mar 2007 16:41:00 EDT

A lawsuit challenging the constitutionality of Sarbanes-Oxley on appointment clause grounds was dismissed this week. I wrote about the suit in the April issue of Reason's "Citings" section, not yet online (subscribers already have it....). Here are comments from co-counsel the Competitive Enterprise Institute on the suit and the dismissal. The plaintiffs will appeal.

Suing Yahoo for Abetting Chinese Gov't

gillespie@reason.com (Nick Gillespie) — Thu, 22 Mar 2007 08:43:00 EDT

The Wash Times reports on the story of Wang Xiaoning, who "has been sitting in a Chinese prison since September 2002. He is serving a 10-year sentence for using the Internet to advocate democracy" via a series of articles critical of the Beijing regime.

His wife, Yu Ling, is in the U.S. looking for legal representation to go after Yahoo, which she claims provided evidence key to convicting her husband in Chinese courts. "I have to help my husband," she told the Times. "I hope Yahoo is punished and the other companies learn from it."

It seems highly unlikely that the case will be successful. Among other things, Yahoo is a minority partner in its own China business. But the Times lays out some interesting questions:

The China dilemma -- the question of whether a company should, as a cost of doing business in a repressive but potentially lucrative country, cooperate with government officials and agree to censorship -- is an issue that Internet companies in particular are grappling with and not unique to Yahoo. Rival Internet companies Google Inc. and Microsoft Corp. are required to filter content in China as well....

"The question that is really up in the air is how much you can associate a private corporation with the actions of a government," says Barry Carter, a Georgetown University Law Center professor who has written casebooks on international law.
In one pending case, known as the "apartheid lawsuit," up to 100 U.S. and international companies are being sued for selling equipment to South Africa's white dictatorship and lending it money. The case, currently on appeal, says corporations such as IBM helped the racist regime stay in power.
"The companies in a way are a proxy for the government because you can't sue the government," Mr. Carter adds.

At this point, Yahoo says only that it "condemns punishment of any activity recognized as freedom of expression. We have expressed our strong feelings about such actions to the Chinese government as well as the U.S. State Department."

Whole thing here.

Sez Oxley: "Never Mind"

rbalko@reason.com (Radley Balko) — Thu, 08 Mar 2007 08:02:00 EST

One-half of the duo that created the most suffocating piece of anti-business legislation in recent history is backtracking:

Was Oxley aware, his questioners asked, that the law that he and Senator Paul Sarbanes, a Maryland Democrat, rushed onto the books five years ago after the collapse of Enron and WorldCom had contributed to a sharp decline in listings on U.S. stock exchanges? And, knowing what he knows now about the cost and effects of the law, would Oxley — who retired in January after 25 years in Congress — have done it any differently?
"Absolutely," Oxley answered. "Frankly, I would have written it differently, and he would have written it differently," he added, referring to Sarbanes. "But it was not normal times."

Good to know. So because of a code-3 case of the "do somethings," rashly-enacted, reactionary legislation is causing the U.S. to lose new listings to London and Hong Kong, corporations that are here face enormous compliance costs, stifled innovation, and a fear of risk, and all we get in consolation is Oxley's mea culpa at a rubber chicken dinner.

Reason symposium on SarBox here .

The 10 Best Business Novels. Or Not.

gillespie@reason.com (Nick Gillespie) — Thu, 25 Jan 2007 16:23:00 EST

Over at The American (the American Enterprise Institute's nicely revamped commentary magazine), the editors have compiled a list of "The Ten Best Business Novels."

Topping the charts is Theodore Dreiser's The Financier, which I've read and enjoyed (what's not to like about a book that spends what seems to be a 1,000 pages describing a battle to the death between a lobster and a squid and then following up with a plot about mass transit scams in turn of the century Philadelphia?). However, why it's at the head of a list of books supposedly chosen first and foremost for "literary merit" is a real brain buster. I have no interest in arguing whether someone is a "great" stylist (such aesthetic distinctions are by turns vapid and masks for other agendas, methinks), but really. Dreiser not only writes like English is his third language, he makes the reader feel that way, too.

Other titles making The American's list include Balzac's A Harlot High and Low (go Vautrin, go); Tom Wolfe's A Man in Full (puh-lease: this book, despite--or perhaps because of--George W. Bush's recommendation, sucks; and don't you get the idea that Bush needs to have someone even listen to audio books for him?); Ayn Rand's The Fountainhead (isn't this a book about sado-masochism and rock quarrying, not business per se?); Sloan Wilson's The Man in the Gray Flannel Suit (reportedly the book that put Terri Schiavo in a coma); and something by Trollope (whatever it is, I'm sure it's even classier than an episode of Yes, Minister).

The point of such lists is to make people bitch and moan, so please proceed to do that. And throw in your neglected faves too.

Mine would include The Great Gatsby (an obvious choice but Meyer Wolfsheim is one of the great unacknowledged heroes of American Fiction); Mildred Pierce (who hasn't baked a pie and dreamed of making millions?); and at least two of the Henry Reed kid novels (Henry Reed's Baby-Sitting Service and Henry Reed, Inc.; Reed was the original nerdtrepreneur).

And where for god's sake is McTeague, typically read as a cry against capitalism and greed (indeed, it's the basis of the von Stroheim film with that name) but in fact a broadside against dental licensing laws (really, even if the author didn't quite intend it that way). And speaking of Tom Wolfe, Bonfire of the Vanities is a great tour de force in terms of "literary merit" (not that I care about such trifles!) that helped create the '80s' ethos even as it was documenting it; more important, it's a fascinating look at Wall Street culture, commerce, and money.

One final thought: The depiction of businessmen as scumbags and low-lifes--was there ever a '70s detective show in which the businessman wasn't the bad guy; how the hell did Mannix, or Barnaby Jones, Jim Rockfish, or even Banacek, for christ's sake, ever make it out the parking lot alive when the cornered malefactor would sic his goons on them?--has no effect on the real world whatsoever. Except when it actually motivates them to kill Ceaucescu and worship Larry Hagman. Which, admittedly, is a mixed bag. But it's something.

Real Estate Protectionism

bdoherty@reason.com (Brian Doherty) — Thu, 04 Jan 2007 13:26:00 EST

Another gem from the pile of magazines and professional journals I've been trying to catch up on around year's end: From the June 2006 issue of Governing, a long and detailed account of the political power of the realtors lobby in various states. It notes that given ongoing improvements in the ability of people to spread information and make deals about houses for sale, that the pro realtor might be in as much danger as the professional old-style travel agent has been in these days of Expedia and priceline.com. Author Alan Greenblatt then notes that realtors (a registered brand name, by the way, that the real estate agents themselves would like to see always capitalized) are doing their level, and influential, best to stop that from happening:

It might be too soon to bet on that scenario, and the reasons are
the involvement of Realtors in the political process and the
protections they have already crafted to stave off the threat. The
many state rules governing their profession, including the newly
created ones such as minimum-service requirements, serve as serious
barriers to entry, helping Realtors preserve their control over the
market.In the opinion of critics, the rules mean both higher fees for
Realtors and higher prices for houses. For Robert Lande, a professor
at the University of Baltimore School of Law who is associated with
the American Antitrust Institute, the new minimum-service laws are
merely the latest phase in a permanent campaign by Realtors to keep a
stranglehold on property transactions. "They've got a sweet deal,"
Lande says. "You fix the rules of the game to insulate each member
from hard competition."

SarbOx: Not Just Dumb, But Unconstitutional?

bdoherty@reason.com (Brian Doherty) — Wed, 20 Dec 2006 16:27:00 EST

The U.S. District Court in D.C. is scheduled to hear arguments tomorrow in a lawsuit challenging the constitutionality of the Sarbanes-Oxley corporate finance reform law, filed by the free-market think tank the Competitive Enterprise Institute, the Free Enterprise Fund, and Beckstead and Watts, an accounting firm.

From the CEI press release, the plaintiffs are

asking the Court to declare [SarbOx] unconstitutional under the Appointments Clause of the Constitution. That clause requires major government officials to be appointed by the President and confirmed by the Senate. However, the five-member accounting oversight board is virtually a quasi-private organization with no accountability to the President or the Congress that created it. It has the power to micro-manage companies’ accounting procedures, impose taxes, and fine companies up to $2 million. Complying with the Board’s rules cost the economy more than $35 billion in its first year alone.

Full CEI study on the topic of Sarbanes-Oxley's unconstitutionality.

Full text of court filing by the plaintiffs. (This filing, despite the CEI press release, does not seem to specifically name CEI as a plaintiff.)

My Reason feature roundtable of interviews from various professionals coping with Sarbanes-Oxley's effects, from our January 2006 issue.

Market Orthodoxy and El Al

bdoherty@reason.com (Brian Doherty) — Mon, 11 Dec 2006 12:46:00 EST

A possible boycott is brewing from haredi (ultra-Orthodox) Jews over El Al, the Israeli airline's, policy that it, and not a rabbi, can decide when it's OK for them to fly on shabbat. The Jersualem Post report.

To their credit, "haredi businessmen in the U.S. have expressed interest in setting up a haredi-owned airline, said Monday Rabbi Yitzhak Goldknoph, secretary of the Rabbinic Council for the Holiness of Shabbat" to compete with El Al. Unnamed Israeli businessmen, however, say that Goldknoph is talking through his yarmulke and could never get a competitive airline off the ground. Still, nice to see boycott and competition offered as a solution to conflicts with a dominant market player.

You Can Be Too Careful

bdoherty@reason.com (Brian Doherty) — Sun, 01 Jan 2006 00:00:00 EST

Adelphia founder John Rigas got 15 years (a life sentence for the 80-year-old executive), and former WorldCom CEO Bernard Ebbers got 25--two victories in the government's post-Enron wave of corporate fraud prosecutions. Meanwhile, the Enron case itself has crawled along, with few significant victories and a handful of defeats for federal prosecutors. The trials of former Enron chairman Kenneth Lay, president Jeffrey Skilling, and chief accounting officer Richard Causey are set to begin in January.

New laws were not necessary to prosecute those executives. Still, Congress responded to the scandals that destroyed or hobbled their companies by passing the Sarbanes-Oxley Act. Signed into law by President George W. Bush on July 30, 2002, Sarbanes-Oxley was supposed to crack down on accounting irregularities, punish those responsible for hiding them from the public, and curtail potential conflicts of interest in corporations' relationships with their auditors. HealthSouth CEO Richard Scrushy was the law's first big collar. He recently walked away from his trial a free, if disgraced, corporate bigwig, after 21 days of jury deliberation. Many credit Scrushy's refusal to testify in his own trial as a plus for him--he left the jury to judge the probity of a bunch of other HealthSouth execs, self-confessed fraudsters who had previously pled guilty and testified against Scrushy.

Sarbanes-Oxley, a.k.a. SarbOx, is a complicated law that has the business world abuzz with annoyance and anxiety. Among other things, it requires that CEOs and chief financial officers certify, under penalty of 20 years in prison and $5 million in fines, that their internal financial controls are in order and that they lead to accurate reports. It says executives must provide "reasonable assurance" that everything is kosher, a provision that is likely to invite litigation as well as prosecution. The law created the Public Company Accounting Oversight Board, adding yet another level of oversight to a profession already monitored by the Securities and Exchange Commission, the Fair Accounting Standards Board, and the Justice Department. The board is ostensibly private, but has the power to force accounting firms to pay both fees for its operations, and fines for disobeying its edicts. SarbOx also requires that auditors (though not necessarily auditing firms) switch out every five years, and it prohibits auditors from jumping ship to executive positions at companies they have just audited.

Critics in academia and business journalism--and many from the corporate world itself, most of whom are reluctant to talk on the record and thereby show "bad faith" regarding the law--have many complaints about SarbOx, from its picayune requirements to its overall cost. While all such guesstimates should be taken with a grain of salt, one financial consulting firm, the Johnsson Group, has put the 2004 costs of SarbOx compliance at $15 billion. The critics also argue that the law's benefits are apt to be small.

America did indeed suffer a wave of corporate scandals that ended in the loss of hundreds of billions of dollars in market value. And the scandals did involve accounting fraud, part of a desperate attempt to cover up the companies' grim realities. But the underlying problem was not crooked accounting; it was bad business practices. A reform aimed mostly at accounting is not likely to solve the problem of stocks that lose value because the people running the company have bad strategies and make stupid decisions and are losing money. In fact, better accounting will speed up the collapse in market value.

Nor is it clear that CEO-certified financial information, SarbOx's main gift to the average investor, will make a noticeable difference. A study by the University of Indiana finance professor Utpal Bhattacharya and some of his colleagues, reported by them in the Fall 2003 issue of Regulation magazine, found that public certification of financial statements by CEOs had no apparent effect on stock prices. That doesn't mean the market doesn't care about accurate financial information; it merely means the market has ways of figuring these things out without legally mandated certification.

SarbOx probably won't cripple the American economy, any more than the Clean Air Act or the Americans with Disabilities Act did. But it's bound to create bad incentives and unintended consequences. Far from increasing the efficiency of capital markets, it will discourage some businesses from going public, since most of its provisions do not apply to privately held companies; will encourage some now-public companies to go private; and will keep some foreign companies out of the U.S. stock market.

According to a survey of companies with under $1 billion in annual revenue done by national law firm Foley and Lardner, SarbOx has more than tripled the average annual regulatory costs of being a public company in the U.S., from around $1 million pre-SarbOx to $3.4 million in 2004. The law also may tend to chill mergers, since purchasing companies will now be legally responsible for the financial records and statements of their targets, documents they had no role in creating.

The costs of SarbOx compliance, while not driving anyone out of business, will siphon revenues toward legal and accounting work. That drain may, in the words of Forbes' Rich Karlgaard, "succeed in stopping the next Enron, but...crib-kill the next Cisco, Microsoft and Starbucks" by leaving them less capital with which to expand.

To get a better sense of how Sarbanes-Oxley is affecting American businesses, Reason Senior Editor Brian Doherty asked four people familiar with the law's consequences to explain what the new rules mean in practice.

Bob Merritt has 23 years of experience as a chief financial officer for restaurant chains, including Outback Steakhouse. He finally left the business in April 2005, partly out of frustration with the way Sarbanes-Oxley and its enforcement changed the nature of his work.

Karen De Coster is a certified public accountant who has done accounting work for a variety of public and private companies for seven years, and is now working in corporate finance for a Fortune 500 company in the auto industry. Although her politics tend toward radical libertarianism, she sees some benefit to "some of what is being done in the name of SarbOx compliance," along with a lot of burdensome requirements that make little sense.

As a Sarbanes-Oxley compliance consultant, Stephen Stanton is a man whose self-interest should encourage him to praise the law. But he sees little good coming from it, aside from added income for consultants and auditors.

Charles Wilson is chairman of the board of Trio-Tech International, a California-based semiconductor testing company with about 500 employees and a market capitalization of $12 million. Wilson, whose company went public in 1981, says Sarbanes-Oxley makes him wish he could reverse that decision.

Responses should be sent to letters@reason.com

Reason: How has Sarbanes-Oxley affected the day-to-day work of people who deal with corporate finance?

Bob Merritt: Section 404 deals with internal controls. That's the part of the law everyone is objecting to most. It says management must certify they have reasonable, cost-effective internal controls to ensure there's no misstatement. The Public Company Accounting Oversight Board has generated rules that require you to certify and test petty cash control--the whole "cost-effective" component gets thrown out. So auditors or people implementing the 404 requirements are requiring lots of duplication of effort.

Here's one great example: If you use an Excel spreadsheet to prepare some numbers for financial statements, auditors want you to prove that you have internal controls in place to guarantee that the Excel spreadsheet adds up. You have to give the spreadsheet numbers to someone and have them manually add them up.

It's hard to explain the frustration, because it's relentless. Every week they come out with new requirements and new regulations, and your day-to-day work becomes more absurd and mired in minutiae. SarbOx isn't the only reason I left Outback--there were a lot of things that happened, and I was at a point in my career where it made sense. But my life at Outback had become just dealing day to day with regulatory matters. I'm a business developer by mentality; I've always been a business person with a financial background. And suddenly I became a cop and a compliance guy. That's not my nature. I want to build things, make things better, and I no longer had time to do that.

I got so frustrated, it wasn't worth coming to work. I'd rather be the guy that holds the pole that the surveyor looks down than be CFO of a public company.

Karen De Coster: As a corporate finance person, this massive body of rules and regulations touches every aspect of my job, including that which seems irrelevant to the big picture, and barely stops short of making me keep Excel spreadsheets of my daily toilet paper use at the office and having the CFO sign off on the roll. Corporate finance people recognize that much of SarbOx is exactly what we strive to eliminate from our work day: non-value-added processes that encumber employees from doing more useful work aimed toward analyzing and maximizing financial position and providing management and shareholders with meaningful data.

Much of this value-added work all but gets lost in the rush to comply with mountains of SarbOx bureaucracy. SarbOx has caused top-end managers and corporate financial people to abandon value-added analysis and process improvement for the sake of day-to-day compliance. The network of planning and tasking involved in compliance with SarbOx is a monster to behold.

Stephen Stanton: Section 404 of Sarbanes-Oxley requires companies to document their internal controls over financial reporting. In layman's terms, they have to make sure the numbers they report are accurate and complete, that everything reported really exists, that all transactions really occurred, and that there is no fraud or material misstatement. They also have to prove how they know there was no fraud or material misstatements and that the reports are accurate and complete.

It's like when you take a test in high school. It's not just about getting the right answer, which is what the traditional financial statement was--the auditor makes sure that the final answers are right. This is more like a math test where you don't get credit if you don't show your work. Even if the numbers are right, if you don't show how you got there, you fail under Sarbanes-Oxley.

Almost all companies have gotten clean auditors' opinions for years, decades, only to discover now they have half a million dollars' worth of work ahead of them to get a clean opinion. Another frustration is that what they traditionally relied on to get to right numbers, there's no evidence that took place. If they have a conference call meeting, it's not enough; now we have to create a paper trail for everything they do. Companies that switched to a paperless system are now buying a heck of a lot of paper.

If you don't create a paper trail, it doesn't count. It's like trying to prove you love your wife: How many flowers did you buy her? What did you get her for Christmas? Lots of little things you wouldn't normally have a receipt for. Every journal entry must be printed out on paper, get two signatures, including either the assistant controller or controller, and be put in binders. Every month they produce stacks of binders that have to be archived. To my knowledge, my clients doing that haven't discovered anything materially misstated.

Reason: What are the costs of complying with Sarbanes-Oxley?

Merritt: We had to have a 4 percent increase in bodies, and incremental costs in year one of 404 certification were $3 to $4 million. But [Outback is] a simple company, not an international conglomerate. And that doesn't count the hidden cost of management time spent on regulatory stuff and not being spent on business development.

De Coster: I don't put a lot of stock in collective statistics. The monetary costs, business by business, have been heavily circulated, even by the mainstream media. Millions here, millions there. Since the costs will be forever ongoing, you can run the numbers any way
you want, and you'll come up with a heck of a lot of zeroes.

However, the bigger cost is in terms of the centralization of a regulatory system that can effectively stifle the free market via the imposition of arbitrary decree. When management makes a decision to implement controls, it's because they see a future benefit accruing to the company. When a bunch of empowered elites in Washington, D.C., implement controls, it's for the purposes of a power grab, face-time in the limelight, and the furtherance of total, central control. SarbOx, in a sense, is a form of central planning wherein D.C. can effectively rein in Wall Street and have complete control over corporate policing.

Stanton: Sarbanes-Oxley compliance fees between my firm and accounting firms can range anywhere from 1 percent of revenues to 3 percent of revenues, or 50 percent of profits. Sarbanes-Oxley could cut off 3 to 4 percent of market capitalization, no problem.

Companies that have been working perfectly fine for years must hire additional people just to segregate duties more clearly. People like me go into companies, and we charge anywhere from a quarter million to a few million per engagement--not just me but firms I'm affiliated with--and we don't produce anything. We don't advertise anything; we don't book any journal entries; we are not a part of the business process. We are an add-on strictly there to produce a few documents.

One thing that defies common sense is that the law requires controls to be documented, so anytime you change your process you have to go back in time to readjust your reporting. Anytime you change the way you do business, install new software, start a new line of business, you need those changes documented. So all of a sudden change is the enemy; creative destruction is a bad thing. We actively encourage clients: Don't change your system; don't upgrade anything; don't change anything for the last three months of the year.

So it really stifles innovation, stifles growth. Some of our clients are systems developers, software sellers, and Sarbanes-Oxley hurt their business, because no company wanted to change [how they do things]; they've already spent time, money, and effort to document their controls as is.

It gives businesses a bigger predisposition to choose inaction over action. There's less intelligent risk taking, a bigger plus for being static and communicating less, because one of Sarbanes-Oxley's requirements is that any document you rely on, whether electronic or paper, to get to the numbers on financial statements, you must preserve, archive it so you can produce it in event of investigation. That is a very sweeping and vague requirement, meaning if someone sends an e-mail saying, "This client said they might not pay, but I'm not sure if it's just a joke," it needs to be preserved. Now they don't want to put anything in writing anymore.

Charles Wilson: Four major public companies are currently dominating the accounting field. As a result, fees continued to go up, and smaller companies like us had to go to second-tier accounting firms to stay in the business. But even second-tier firms, because of fear of liability, have become very expensive for small public companies. I'm involved in two other private companies and have been for years, so I'm quite aware of what accounting fees normally cost for private companies compared to a public one of our size, and the costs are four times higher--and that was before SarbOx came into being.

Now our accounting firms no longer can give suggestions on how to help you do better work, because they want to stay independent, and for them to remain independent they can't tell you what to do. They can only tell you you are doing it wrong. So now you have to pay two sets of independent groups, one checking internal operations to see they all are correct and another ensuring that you are doing them the most proper way.

The other problem with small companies is what you call materiality. What's considered material to a $25 million company vs. a company doing $1 billion in business is vastly different. So a small company has to pay auditors to go over every tiny item. $10 items have to be gone over carefully, whereas for a large company $1,000 can be overlooked. So that causes more money to be spent on accounting.

We will not make any money this year by the time we pay our accounting fees. Compliance has been delayed until July 2007 for smaller companies, but we have already started setting up the new systems.

And it's not just accounting fees. It's legal fees. The lawyers want to make sure you're complying with SarbOx, so you have them checking everything too.

Reason: Are there any benefits to Sarbanes-Oxley?

Merritt: Most of the law's requirements won't help investors and won't stop Enrons and WorldComs. I don't know how regulators will look investors in the eye next time there's a big blowup.

De Coster: The hardest thing for me to admit, from a libertarian yet practical corporate finance viewpoint, is that some of what is being done in the name of SarbOx compliance is very much needed within the corporate environment. The beneficial elements of SarbOx's requirements should have already been put in place by company management. Internal controls within many Fortune 500 companies were in disarray.

According to Compliance Week, which monitors the reporting of internal control weaknesses, March 2005 had 116 companies disclosing material weaknesses in their internal control over financial reporting, up from 28 for the same period in 2004. This is because '05 was the first year that companies had to provide internal control assessments as per Section 404 of SarbOx.

So is there value in SarbOx for stockholders? Yes, there is. But the fact that government usurped private processes in reaction to a host of big business failures sets the stage for a huge regulatory era in which businesses may no longer be able to operate outside of the realm of strict oversight and congressional decree.

Should the private accounting bodies have cleaned up their act prior to the domino effect of business failures? Indeed. The profession has not done a good job of changing the way it does things. It has allowed the old system to stagnate, instead of rolling with the times. The current financial environment of short-term finagling, tax avoidance, and revenue boosting for the sake of pleasing the latest Wall Street analyst of the day has skewed the way the accounting profession does things. You can thank government's abysmal tax policies and Fed-created credit bubbles for crafting most of those problems. Artificially inspired booms, courtesy of the Fed and monetary policy, will likely lead to corporate malfeasance.

Stanton: The only benefit this law can have is reducing the number of restatements. And the number of financial restatements in any give year is maybe 1 percent, maybe 2 in a bad year, and those don't take a company worth billions and turn it into one worth nothing. It's more likely to take a 10 percent hit, so maybe 1 percent of your portfolio takes a 10 percent hit in a given year due to financial restatements in a pre-Sarbanes-Oxley world.

Most business failures have nothing to do with accounting, stated financials, or fraud. Most business failures have to do with having wrong strategy, inefficient operations, poor marketing. Sarbanes-Oxley only puts CEOs on line for accounting risk, mistakes in financials. And that will shift their focus away from the 80 percent of problems businesses are likely to face to concentrate on 20 percent of the problems, because now that's what they'd go to jail for or be fined for.

Wilson: The day Sarbanes-Oxley passed was a great day for the accountants. It was an Auditors Relief Act. Now if you could afford to have everything double-checked like this, it would be terrific: Prove you are clean as a whistle and, God forbid, if you have some problem within the company, this really shows it up much sooner. But most companies can't stay in business if they do have problems anyway, and it's a very expensive way to keep everyone on the up and up.

If you had a problem, say, in a subsidiary, in terms of knowing whether or not it's really making money or if one of your executives is faking some of the information--which happens in small companies that aren't closely monitoring their people--in the long run the new system will pick up fraud and poor performance, and the company will become more efficient. But the question is costs balanced with benefits. I couldn't run stats on it, but I do know the costs of being public today are prohibitive. We would never go public in this market, and if we could afford to buy back the stock we'd go private.

SarbOx requires us to be much more careful, but we were doing that anyway. For those who don't want to do careful accounting it might be a good idea, but there are much more efficient ways to do it. The double layer of accounting oversight is unnecessary.

reason: Will criminal liability for CEOs and CFOs whose companies' financial statements are deemed inadequate be an effective deterrent to fraud?

De Coster: SarbOx can turn a CFO into a criminal overnight. So, yes, SarbOx requirements can make officers more fastidious in regard to thefinancial information going out the door. On the other hand, the officers with the sign-off responsibilities are not in the trenches, do not know the details, and quite often do not have any ideaabout what they are signing off on. The division of labor is such that they have to trust their employees to do the best job possible, and, the financials themselves aside, they often end up signing off on stuff when they don't even have the time to glance at it. It would be unrealistic to say that they could or should spend their time absorbing such details.

Stanton: No matter how much work we do, we can't prevent fraud or collusion. We ensure segregation of duties, make sure it would take two or more people acting in concert to slip something by. But it's real easy to make a friend and find someone to commit fraud with if you're hell-bent on doing it. Having CFO certification creates a laddering effect: He relies on the controller, who relies on departmental managers, who rely on accounting staff, and they all have to watchdog on each other and create a finger-pointing environment. In that sense you can get some degree of assurance, but you can't eliminate fraud.

Reason: How have your colleagues reacted to Sarbanes-Oxley?

De Coster: The public accounting and professional servicesfirms are ecstatic over the growth potential provided by SarbOx. The accounting firm KPMGreported that respondents to a survey overwhelmingly replied that the SarbOx Act has "boosted investor confidence in corporate America," whatever the heck that is supposed to mean. The American Institute of Certified Public Accountants brags that Section 404 "opens new doors" to consulting opportunities. My profession has always supported regulation, since it enhances revenues and growth opportunities.

Recall thatthe average accountant sees government regulation and oversight as a part of daily life, a necessity for everyday business maintenance and survival. They tend toward thinking that the absence of ironclad regulations would be akin to chaotic anarchy. Theprevailing commentin regard tothe SarbOxenvironment is, "It's been good for us, making us do things that should have been done before." Laissez-faire isn't exactly rampant among my colleagues.

But the SarbOx snare has produced some serious skepticism in the corporate world. When the effects of unchecked statism come home to roost, those most affected by it firsthand eventually rise up in resistance to the lunacy of it all. The average accountant or corporate finance individual has seen the light in regard to the sheer folly of it all, from having endured microscopic attention to even the most insignificant tasks. The more ridiculous the compliance procedures get, the more the average workertends to blow it off as frivolous.

Wilson: SarbOx is definitely discouraging smaller companies from going public, and it discourages good opportunities for investing in little companies. I have friends running private companies who say going public now would be just impossible.

Merritt: I can't tell you a single public-company CFO I know who hasn't wanted to leave in the last year, but maybe they're not in the financial position or age bracket to do that. We're not in business anymore. We're just in compliance.�

Fannie Business

jsanchez@reason.com (Julian Sanchez) — Sat, 01 Jan 2005 00:00:00 EST

Fannie Mae, the government-chartered corporation charged with providing liquidity in secondary mortgage markets, exists in the twilight realm between private and public. A report from the agency charged with overseeing the company suggests that its accounting records had a certain hallucinatory quality as well.

An investigation by the Office of Federal Housing Enterprise Oversight found that Fannie Mae systematically misapplied generally accepted accounting practices and manipulated earnings reports to maintain an aura of stability. Executive bonuses were tied to meeting earnings targets, providing a powerful incentive to "adjust" the books. In one year examined by the office, Fannie Mae met the target "right down to the penny," guaranteeing a maximum bonus. In October, responding to the report, the Securities and Exchange Commission launched a formal probe of the company.

The report finds that Fannie Mae's dodgy practices began about six years ago. So why has it taken so long for them to be noticed? One contributing factor: Official policy notwithstanding, there was a widespread perception by investors that the company was "too big to fail" and would be bailed out by taxpayers if it ran into trouble. As Federal Reserve Chairman Alan Greenspan put it in congressional testimony in early 2004, "The problem that exists is because they have a subsidy, granted not by the Congress but by the expectation that government will bail them out in the event of a crisis."

This assumption gave markets a false sense of security, even as Fannie Mae expanded its portfolio to take on more risk. As a spate of recent corporate scandals shows, you don't need strong ties to government to do fraudulent accounting--but apparently it helps.

Diva Down

info@reason.com (Elizabeth Koch) — Tue, 09 Mar 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

"Maybe this is a victory for the little guys who lose money thanks to these kinds of transactions," Chappell Hartridge, a 47-year-old computer technician and jury spokesman, announced to the press, cocking his eyebrows and clasping his hands. "Maybe the conviction will give the little guy more confident feelings that I [sic] can invest in markets and get in on the up and up," Hartridge was speaking to reporters after finding Martha Stewart and Peter Bacanovic guilty—of everything. Lying, conspiracy, obstructing justice. And a hell of a lot more. If Judge Miriam Cedarbaum hadn't the foresight to throw out the securities fraud charge, the jury would've slammed that on her too.

If scoring one for the little guy was this jury's priority, the dispensers of justice should have thought a few steps ahead. Or just observed their surroundings. Because from the instant the government made Stewart its corporate fall gal—even without the help of insider trading laws—Martha Stewart Living Omnimedia (MSLO) shareholders have watched their fortunes evaporate. The assortment of charges the SEC stuck Stewart with, albeit flimsy and drifting as post-it notes, was enough to rattle investors and initiate a landslide of company layoffs. After the verdict was announced, MSLO stock dropped from $17 per share to $10.86 in a single afternoon. No doubt it's got a lot further to go. Martha Stewart isn't the one who's hurt the little guy. The government did that all by its lonesome.

I believe Hartridge's comments to the press last Friday were utterly honest. He spoke with assurance, with growing passion and confidence. I thank him for making it clear that the jury found Stewart and Bacanovic guilty of arrogance. "Judging from some of the things they did, I'd say they thought they were special, he said, "like they were better than everyone else." Arrogance is not a noble trait. But if we start convicting people for having crappy personalities, well—a prison complex that immense could only fit on the moon.

Chappell would have been wise to keep his mouth shut. But he couldn't. He was pissed. He had an ax to grind. While reporters stood on tables and chairs, their pens poised to record his every word, Hartridge rattled off a list of Martha Stewart's transgressions. Most had little to do with the actual charges.

Offense Number One: Stewart's stockbroker background. "She should have known better," Hartridge scolds. "The things she did once she felt the heat, not cooperating with the authorities—she should have known what was illegal." The obvious assumption is that she did know better, and didn't care. That she purposely thumbed her nose at the SEC in particular and the law in general, that she—in typical "big wig" fashion—ostentatiously ignored the rules everyone else had to follow. Perhaps Chappell's right to some degree. Martha could very well have rushed her SEC interviews, could easily have appeared huffy and irritable. But for the jurors to conclude beyond a shadow of a doubt that Stewart told boldfaced lies, they'd have to ignore attorney Robert Morvillo's persuasive argument that the government proceedings were shoddy and misleading.

Offense Number Two: The appearance of celebrity supporters, like Bill Cosby, Rosie O'Donnell, and Brian Dennehey. "What did she think, they're supposed to sway our opinion?" Chappell sneered when asked, admittedly insulted and outraged. He seemed to consider the celebrity appearances a deliberate scheme to impress, a cocky bribe to let Martha off easy. "Maybe [Stewart's conviction] will be a message to the big wigs," he says with assurance.

Offense Number Three: Stewart's defense calling one measly witness. "It seemed like they thought they could fool us by [making no effort] to defend her. Like her actions didn't need to be defended." It's true Robert Morvillo's decision was a gamble, one that came off as pompous and condescending. The jury's indignation is perfectly understandable. But to convict, even in part, on the grounds of a perceived slight? Bogus.

Offense Number Four: Stewart's allegedly writing off personal vacations as a business expense. "It's like she thinks she's better than everyone else, that she can do whatever she wants." Sure, if Martha's billing her company for what amounts to luxurious self-indulgence, that's slimy. But the accusation, as Judge Cedarbaum would say, "is neither here nor there"—it has nothing to do with this trial's charges. It's a red herring. Prosecution brought up the vacations as a distraction, as alleged proof of Martha's greedy overconfidence. In any other context, such a fault would be considered a character flaw, a charge we're all guilty of. Does it warrant jail-time? God help us.

Offense Number Five: Mariana Pasternak's "best belief" testimony. If a witness and good friend of the defendant first boldly quotes the accused as saying "Isn't it nice to have brokers who tell you those things," then claims not to remember much about the context, then claims that what she thought was a comment may have been "a string of words in her own mind," how could such a testimony raise anything but doubt? Hartridge, as the jury's voice, says otherwise. He calls Pasternak's belief one of the "strongest pieces of evidence against her."

Offense Number Six: Tampering with Ann Armstrong's message log. "Why would Martha delete Peter's message [that 'ImClone is selling downward'] unless she was trying to hide something?" Hartridge asks. He's right about it being an idiotic move. He's right that something alarmed Stewart enough to edit the note then abruptly change it back. But he's wrong to assume that something was a crime. Consider the culture we're living in, its litigious environment of wildfire lawsuits. So she caught a touch of the paranoids moments after being warned by her lawyer about SEC investigations of December 27 ImClone trades. Who wouldn't? Martha's not stupid. It's possible she went looking for material the government might find suspect, came across that message, realized how it could be interpreted, and panicked. Who in her position wouldn't put on her prosecutor goggles and study every potential piece of evidence through its slanted eyes? It was a rash act, yes. Suspicious even. But does it prove she's guilty, or even that she believes she is? Hardly. Most senseless of all is that the note, the message Stewart temporarily altered, was perfectly legal broker-to-client information. Thoroughly, undeniably, maddeningly legal. Once again, she's not condemned for actual wrong-doing. She's condemned for behaving like a criminal.

Offense Number Seven: Douglas Faneuil's tax-loss agreement story. How the jury members failed to question Faneuil's farfetched accusation—especially in light of his past lies and government deal—is incredible. Were they even listening? "I feel bad for Faneuil because he got pulled into this. From the start he felt like he had no choice," Chappell says, buying the accomplice witness's deposition without so much as puzzling over incentives. Faneuil's tax-loss testimony, as both defense teams repeatedly proved, made no sense. First, Peter Bacanovic knew damn well ImClone sold at a profit and would never have pretended it belonged on Stewart's 2001 tax-loss plan. Second, Martha's business manager Heidi Deluca could not have accidentally alerted Faneuil to the absurdity of his boss's first so-called cover-up in early January. Why not? Because up until February, when she received Merrill Lynch's 1099 form, Deluca believed the ImClone sale went toward the 2002 tax plan. It wasn't until February that Heidi called Faneuil in a fury, weeks after both Bacanovic and Faneuil told compliance officers about the $60 sale agreement. Reasonable doubt smashed this testimony to pieces. The jury looked the other way.

And finally, Offense Number Eight, the truly damning one, the one that's informed all the others: Martha Stewart's reputation. Way before we ever heard the name Doug Faneuil, this woman was widely known: as a crocheting, pottery-throwing, wallpaper stenciling, eyelash-batting control freak bitch. As smug and obsessive and self-absorbed, a tyrant to work for and a pain to work with. As someone who freely dubs her employees "idiots" and "little shits," who hangs up on secretaries and assistants who fall short of her bidding. For decades Stewart's been accused of wanting things her way or the highway, for being dramatic and absurd and roaring like a lion, for making bizarre threats like pulling out of Merrill Lynch if they don't get better hold music. For acting entitled, as if she doesn't have to follow the "little people" rules. And this is precisely what the justice-keepers have charged her with: in short, being a diva.

No one's gonna feel sorry for a jet-setter. No one's about to consider a socialite with five homes, expensed limo service, and her own celebrity television show a victim. Especially if she's a bitch. No one likes arrogance. It's a shitty quality, one that makes employees quit and couples break up and friendships buckle like old tuxedo shirts. That a jury confronted with such a mix of bad personality traits would put the worst possible interpretation on all evidence and behavior is understandable.

But a precedent has been established, or reaffirmed—that the government can walk in and destroy your life; that if you get nervous while dealing with federal investigators on a fishing trip (one in which no criminal charges are ever filed), you'll go to jail; that punishing arrogance is worth demolishing one of the most successful American businesses of the last decade. It's unlikely any actual little guys were hurt by Martha Stewart's 3928-share trade, which earned her $51,000 dollars and her broker a $450 commission. It's inevitable that many Americans will be punished by the government's ever-expanding definitions of criminality and its ravaging of capitalism's most successful products. If you think you're little now, you ain't seen nothing yet.

Martha's Reign of Terror Over the Little Guy Is Over!

info@reason.com (Elizabeth Koch) — Fri, 05 Mar 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

By 2 p.m., the end of lunch hour, cameramen flood the bottom of the courthouse and security lines the stairs. In the courtroom, the defense and family sit in choked silence, waiting for Judge Mirium Cedarbaum to return from chambers. When the clerk finally knocks—"All rise"—an hour has vanished.

Cedarbaum walks in swiftly, her face stiff and gray, and says without pause, "The jury has reached a verdict."

The jurors take their places, each and every one looking at their shoes, their faces cast in shadows. Cedarbaum reads off Martha's counts with rapid-fire force, "Count one: Guilty. Count three: Guilty. Count four: Guilty. Count eight: Guilty." Guilty on all counts. Stewart's daughter, Alexis, who sat directly behind her every day of the six week trial, drops her head in her hands and shakes. Her estranged husband, John Cuti, Martha's number three defense lawyer, does the same. But Martha—she hardly flinches.

Martha Stewart's convictions are as follows: conspiracy (specifically obstructing an agency proceeding, false statements, and perjury); false statements (two counts); and obstruction of justice. Peter Bacanovic is found guilty of conspiracy, false statement, perjury, and obstruction of justice—he's not charged with making and using false documents. I could not see his face, nor that of his parents. For a moment there is only silence, a thunderous sort of stillness. Cedarbaum thanks the jury and when they stand, reporters rush out. "I must have missed something," says Slate reporter Henry Blodget. I nod. Our blind spot will soon become embarrassingly evident.

When I reach the hallway, I hear someone yelling. Wailing, really. It is Peter Bacanovic's tiny, shrunken mother, jabbing her finger at the New York Post's gossipy opinion writer, Andrea Peyser. "You wanted this all along. He might look good in an orange jumpsuit, but he lost his career and his job and he had no motive." That should be grist for Andrea's mill for months to come.

In the press room, juror number eight, Chappell Hartridge, a computer technician from the Bronx, is kind enough to stick around and clarify their decision.

"Maybe this is a victory for the little guys who lose money thanks to these kinds of transactions. Maybe it's a message to the big wigs." Frankly—and stupidly—this kind of emotion surprises me. Yes, on day one the jury seemed to buy into prosecuting attorney Karen Seymour's Disney movie good vs. evil opening argument, but in the days that followed its members appeared genuinely conscientious and attentive. At this point, one thing's for certain—they took each witness's testimony, and every piece of evidence the prosecution put forth, at its surface value, without bothering to look a little deeper. By that I mean the statements of Douglas Faneuil, Ann Armstrong, and even the befuddled Mariana Pasternak.

In response to whether Faneuil's testimony was the defining factor, Chappell says, "We did not take Faneuil's testimony for gospel. I kept an open mind because he had an agreement with the government, but I didn't think he was slick on the stand. I felt bad for Doug [my italics] because he got pulled into this from the start and he felt like he had not choice [but to follow his boss's orders]." As for Mariana Pasternak, it came down to the misleading statement the judge allowed the jury to sleep on before cross. Chappell continues, "The fact that she said, 'Isn't it nice to have brokers who tell you those things?' That's pretty persuasive."

"But what about when she said she wasn't sure about that?" a reporter shouts. "She said it could have been a thought."

Chappell blinks at her for a minute. "Well, that wasn't the only thing. It was also other evidence."

"Like what?" we all shout in unison.

"Ann Armstrong's testimony was probably the strongest. There had to be a reason Martha was trying to delete that message [that ImClone was selling downward]. I mean, if the message had said, 'the stock is @60, now it's time to sell as per our agreement,' then that would have been okay." I guess so. These guys are rather, uh, literal.

It was easiest to convict Martha, Chappell said, especially on the false statement charge. "We convicted her by early on in the second day of deliberations."

"Did anyone think she was innocent?" By evening, he will tell MSNBC's Dan Abrams that there was no dissent among the jurors.

Pause. "No comment," Chappell says, looking the opposite direction from the questioner.

Someone asks if Martha's background as a broker was a factor. "Absolutely," Chappell nods. "She was a stockbroker so she should have known the rules. Some of those things she did once she felt the heat show that she should have known better. Especially the omissions."

"How'd you think Morvillo did defending her?"

"He did the best he could with what he had to work with. It bothered me that they only put one witness on the stand. It's like they were saying, 'I don't need to defend myself. I don't need to persuade the jury. We know we'll get off.' It was kind of."

"Arrogant?" Andrea Peyser asks hopefully.

"Yeah," he says. "Judging by some of the things they did, I'd say they thought they were special. I wasn't comfortable with the tone of [Peter Bacanovic's taped SEC testimony]. He sounded kind of."

"Arrogant?" Andrea asks, nodding emphatically. "What about the fact that Martha charges her vacations to the company? Did that play into your decision?" What, Andrea, do you want him to admit the conviction was motivated less by evidence than character assassination and vengeance?

"Yeah. She takes vacations and doesn't pay for them—it's like she thinks she's better than everyone else. But, I mean...the vacations didn't factor into our decision."

"What are you thinking of in terms of insider trading?" someone asks.

"Well, as I understood it we weren't supposed to consider insider trading. But as far as not talking to the authorities and not cooperating, yes, she sounded like she thought she was better than everyone else."

In spite of all that, Chappell says he believes the conviction a tragedy of sorts. "We took our job very seriously. I don't care if it's Martha Stewart or John Doe, these are two people's lives we're dealing with. The decision will affect a lot of people—[Martha Stewart Living Omnimedia] employees, stockholders... But maybe this conviction will give the little guy more confident feelings that he can invest in the market and get in on the up and up."

"I—we all—came to this decision with an open mind," he promises.

Sentencing will take place on Thursday, June 17, 2004. Both defendants must report to a probation officer within a week of proceedings.

Judge Orders No Dream Dates With Sheltered Twelve

info@reason.com (Elizabeth Koch) — Wed, 03 Mar 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

Judge Miriam Cedarbaum spends the early morning hours reciting a condensed version of her jury charge, defining in minute detail circumstantial evidence, unanimity and accomplice witness testimony. She invokes Douglas Faneuil in the latter, "I caution you to scrutinize the accomplice's statement with particular care. Ask yourselves would he benefit more from lying or telling the truth? Did he believe his interests would best be served by testifying falsely or truthfully?" Slam dunk for the defense.

On every count—eight between them—Cedarbaum emphasizes absolute concurrence. "In order to reach a guilty verdict, all jurors must agree that the defendant made at least one false statement or concealed at least one material fact within any given count, and that he or she did this knowingly, willingly and willfully, purposely disregarding the law. It's not enough that some of you agree on one and some the other. The decision must be unanimous."

Throughout her two-hour lecture, only on one instance only does Cedarbaum's language veer from abstract, cyclical legalese: she tells a story (of sorts) to explain circumstantial evidence: "Suppose the day was sunny when you arrived here today, that the blinds were drawn, and someone walks in the room with a dripping umbrella. Then someone else comes in with a dripping raincoat. You may have no direct evidence that it's raining, but based on a combination of fact, reason, and common sense, you may infer that it is." The description chimes in my ears like poetry, like "Bohemian Rhapsody"; from that you may infer the morning was dull as ditchwater.

Around 12 p.m., shortly after the jury's dismissed for deliberations, Cedarbaum receives a note.

"A note!" she chirps. "My jury's had an opportunity to bond," she says, smiling at the yellow college-rule paper as if it were a photo of her grandchildren. "They request to have lunch now so as to include the substitutes, who'll be dismissed once they begin deliberating."

Awww.

Her kiddies pass forward two more notes throughout the afternoon, requesting a phone chart of the calls in and out of Peter Bacanovic's office on December 27, Faneuil's testimony on the same, Annie Armstrong's message logs, Peter's cell and office phone records from 12/27, and SEC officer Helen Glotzer's testimony regarding Peter's February 13 statements. They want one of FBI agent Catherine Farmer's documents, but they can't have it. It's not in evidence.

There is a popular theory that Judge Cedarbaum despises the press; the evidence in support of it is more direct than circumstantial. She says she keeps close watch on her jurors out of respect for their privacy, but her policies seem imperial. Screw the public; they needn't know what goes on here. This is my show. Kind of like what defense attorney Robert Morvillo says about the SEC folk—they run their interviews any damn way they please.

Case in point, an unfortunately smarmy-looking media lawyer crawls out of the floor vents mid-afternoon, during jury deliberations, and approaches the podium. I can't hear his questions, but no matter: Her Honor's response renders them moot on arrival.

Judge: I've never in my eighteen years of practice been asked for the juror's addresses.

Counsel: But...

Judge: In this district and this circuit I'm unaware of any case where the addresses have been requested, let alone granted.

Counsel: I respectfully disagree...

Judge: That was not a criminal case. While we're comparing states, the rule in Connecticut is that neither the address nor the names are released.

Counsel: [Cough. Inaudible question.]

Judge: I certainly do not want to interfere with any juror who wants to be interviewed once I release them.

Counsel: [Inaudible comment.]

Judge: The jurors were made aware the questionnaire would never be public—it's a very unusual request to ask me to violate my promise to the jury.

Her laugh summons visions of a hurtling gavel. Hope the guy has quick reflexes.

Counsel: The public had a right...

Judge: My word is my bond.

Counsel: (Inaudible statement.)

Judge: What case? No Supreme Court case advises it should be made public.

Counsel: [Inaudible statement.]

Judge: I have no intention of preventing reporters from doing their job. My job is to preserve the system of justice and the jury's privacy.

Counsel: [Inaudible question.]

Judge: Cameras are not allowed in the courthouse.

Counsel: [More.]

Judge: What possible relevance? What possible relevance does the face of a juror have on the public? Besides to help sell newspapers.

Counsel: [More.]

Judge: Well, that's fine. This trial is sui generus in many regards. What else?

Assistant U.S. Attorney Karen Patton Seymour stands: "I would suggest that, to prevent jurors from being harassed, we establish some means of addressing that potentiality."

Judge: I think I can rely on the integrity of the press not to disobey my orders.

The sad little man leaves. Just as the door slams on his heels, Cedarbaum starts yelling, "Is the media lawyer still here? Will someone get him?" A court attendee hauls him back in front of the judge. He stands before her, wrists crossed at his back, chin to trachea.

Judge: I've just received notice that both Illinois and North Carolina agree with my practice.

She smiles and tries to shoo him away again, but he begs for one last scrap.

Counsel: [Inaudible.]

Judge: I'd say, from the time I receive the note and the jury gets seated—about five minutes. I cannot hold up the verdict so a town crier go round people up.

I guess we'll be camping out. And by the way, if anyone's interested in buying a transcript of the trial, the total is $5,327.30 to date. Yeah—the courts assumed you wouldn't be.

Cold Case

info@reason.com (Elizabeth Koch) — Tue, 02 Mar 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

Richard Strassberg, defense attorney for Peter Bacanovic, ends his closing arguments by stressing motive: Douglas Faneuil only comes forward after the ImClone buzz at Merrill Lynch has seeped into the press: Faneuil can no longer hide from the fact that he's the shining center of the entire ImClone scandal. He's the one who performed the Merrill Lynch trades that landed Sam Waksal in jail; it's his statement that informed the SEC, compelling them to investigate further. No surprise that he's suddenly scared out of his mind, Strassberg says, now that it's clear whatever deal the government supposedly made with Merrill Lynch has vanished. Or erupted. Now would be the time to come forward, before he finds himself lying in criminal court. But of course, Strassberg stresses, lying on the stand is exactly what Faneuil has been doing. He has to. If he doesn't stick to the story he and the SEC agreed to, the deal's off. The government will trash the bogus misdemeanor bargain; and Sir Faneuil will not only be tried for a felony but face a brand new perjury charge.

The jury seems genuinely focused, but a few press people sigh loudly and roll their eyes. I frankly don't blame them. Strassberg may be dead-on in terms of content, but keeping his voice below a hysterical pitch would get him farther.

Strangely, when Strassberg arrives at his heart-jerking conclusion—one that might warrant a little drama—his voice drops to a kinder, more gentle timbre. "It's frightening that you could be fighting for your life over a pronoun," he says, referring to the mis-transcribed February 13 SEC meeting, the only meeting the government bothered to tape, which substituted "We" for "I" in Peter's statement that "We told Martha" ImClone was trading downward. "It's understandable that someone made a mistake, but a mistake should never be used to charge someone with a criminal offense." The jury box gasps and becomes still, as if the jurors have had the collective wind knocked out of them. When the pause breaks, heads rush toward notebooks.

"There's only one time for Peter Bacanovic. That time is now. He's a victim, caught in the crossfire about the events of a phone call he wasn't privy to, caught in the crossfire of the government's attempt to make a case against Martha Stewart. He made a mistake (letting Faneuil handle Martha's trade), but was not willing to take a deal that would wrongly implicate his friend. He's lost his reputation, his career, everything he spent over nine years building, and now his life and liberty are also on the line.

"You are here to prevent overreaching and the twisting of facts. I trust you will do just that."

Stewart defense counsel Robert Morvillo begins with his usual clarifying analogy: "The government has accused Martha Stewart of participating in a Confederacy of Dunces!" Heads jerk and eyes widen. "If two smart, successful people were to sit down to concoct a story, wouldn't they make sure to match them up? Wouldn't they have made at least certain aspects of it cohere? Look at the gaping inconsistencies! They fall down on the very first element of the case!"

He goes through a litany of discrepancies that surround the $60 arrangement and ultimate sale of ImClone stock—when they made the agreement, where they made it, who else knew about it, and when they were told. "They couldn't even get straight who took down the order and executed the transaction! What kind of conspiracy is this? It's a Conspiracy of Dunces!" The jury looks somewhere between amused and stunned.

Before launching into the conspiracy charge, Morvillo mentions something prosecuting attorney Karen Seymour said in her opening arguments: that the Waksals were "trying to sell every last ImClone share they held. That was an inaccurate statement," Morvillo asserts. "Sam Waksal only held 2 percent of his over three million shares at Merrill Lynch. Do I think Seymour's a liar? No, of course not. She made a mistake. Just like Martha made a mistake when she thought she was speaking to Peter instead of Faneuil, jut like Heidi thought she wrote the note on November 7 instead of in October."

With that hit, he confronts conspiracy—the government's argument that Peter and Martha met after December 27 to get their stories straight. Morvillo asserts there was plenty of non-ImClone related activity in Martha's account from January 7 to April 10, the period in which the SEC interviews were conducted, that demanded broker and client conversation. In the beginning of 2002, Martha sold a chunk of her Martha Stewart Living Omnimedia stock for $45 million. "This is not $450 we're talking about," Morvillo says, referring to the amount of commission Bacanovic made off Stewart's December 27 ImClone dump. "There's not a shred of evidence that anything going on in any of those conversations was improper or conspiratorial." As for Faneuil's word...

"Faneuil testified that when Peter returned from his January 16 breakfast meeting with Martha Stewart, he said, 'We're on the same page,' about the $60 agreement. They weren't on the same page, they weren't even in the same boat! To believe the government's story, you'd have to believe these two people got together to conspire and couldn't get it right."

Brian Schimpfhauser, a Merrill Lynch market surveillance officer, accuses Peter of sending Martha a signal that something was going on with ImClone. But why, Morvillo asks, would Stewart assume Peter's "signal that Waksal was selling stock in his company" meant something [awful]? She believed the FDA would pass Erbitux anytime soon. There are all sorts of reasons Sam could have been selling—to diversify, for immediate cash, because the price is trading downward—"how would Martha know Sam would go insane...that he would be dumb enough to sell right before a black-out period [right before the FDA denied approval of his wonder drug], when he knew he'd have to file within ten days? And that his sale would be scrutinized?" At least half the jury is taking notes, the other half lean towards Morvillo. Even sleepy Juror 11 is writing in her notebook.

About the same Feb 4 meeting, Morvillo later asks, "If there was any doubt about what was talked about in that meeting, why didn't the government subpoena David Marcus (Merrill Lynch's general counsel), Steve Snyder (head of Merrill Lynch market surveillance), or Jill Slansky (FBI agent who took notes)? Why'd they call on Brian Schimpfhauser, the rookie whose job is to stare at the computer, the one with the haziest recollection? Why not call in experts about what happened in [Faneuil's] January 3 statement or [Bacanovic's] January 7 phone interview?" Several jury members cock their heads simultaneously, as if thinking, "Hey, that's right! Why the hell didn't they?"

Morvillo nails the government for mishandling Stewart's interviews in general. The FBI did not tape or transcribe them, the SEC did not tell her she was under oath, and the participating agents did not read her the SEC rules of compliance. First, Morvillo argues, "How can you say whether Martha dodged questions or responded in full when no one bothered to record the questions? Not recording the interviews allows the government to go after you any way they want."

Assistant U.S. Attorney Michael Schachter objects.

Second of all, "How can you accuse Martha of even knowing these were legitimate SEC meetings? The real deal? They didn't hold the interviews in the SEC office, nor did an actual SEC officer conduct the interview—the assistant United States Attorney did. How can you accuse Martha of willfully obstructing justice and lying to officers of the law when they were conducted so informally? The questions themselves were misleading—the interviewer doesn't give Martha a chance to rethink her erroneous belief that she preformed the December 27 trade with Peter, but instead leads her down a misguided path, trapping her in her error and calling it a lie. They take shoddy notes, then use them to tie Martha's "I don't know" response to a question about whether a record existed of Peter's December 27th message ("ImClone is trading downward") rather than when the message was recorded."

Morvillo spends some time on Peter's "@ 60" document, the spreadsheet that lists Martha's 2001 most ailing stocks. He points to the circled Apple, Nokia, and ImClone stocks, and says, "Even the world's leading ink expert agrees" these marks were made with the same pen. "When Peter circled those stocks, he wasn't doodling. The only reason to circle the stocks was because there was something to do. They sold Apple and Nokia on December 24; there was one stock left to get rid of," one Martha wanted to hold onto both out of loyalty to her good friend Sam, which Mariana Pasternak testifies to, and because she still believed Erbitux would be approved.

Morvillo takes as many hits at Faneuil, whom he describes as the centerpiece of the government's case, saying that he told half-truths he told on the stand. Way too many to record. "Heidi Deluca, Martha's business manager, puts the nail in Faneuil's recollection. Faneuil claims Heidi called him in the beginning of January all mad that ImClone sold at a profit, which screws up Martha's 2001 tax-loss plan. But in January Heidi still believes ImClone belongs on the 2002 tax form. She doesn't ball him out until February, when she gets the 1099 from Merrill Lynch that demonstrates she was wrong.

"Peter had told Faneuil about the $60 agreement at least a month before Faneuil and Deluca's February conversation. But Faneuil testifies that it wasn't until Heidi alerted him to the big flaw in the tax-loss story—that it sold for a gain—that Bacanovic changed his story to the $60 agreement. In February? There had been multiple SEC interviews by that point. It could not have happened that way.

"Instead of giving you proof of anything, the government gives you Douglas Faneuil, the very definition of reasonable doubt."

Juror 1 looks up from her notes to smile.

Morvillo gets in one final dig. "When Faneuil was asked whether he was prepped for his testimony, he said yes, 'But they didn't ask me all these questions.'

"Tell us, you of the prodigious memory," Morvillo booms, "tell us one question they failed to ask you. One question you were surprised by on direct:

"'I can't remember.'"

Morvillo ends his statement by imploring the jury: "Let Martha Stewart return to her life and improve the quality of life for all of us. If you do that, it's a good thing."

Seymour's rebuttal is so slipshod it's almost not worth mentioning, not least because the jurors look absolutely fried. Many sit with folded arms and fidget throughout her comments, pleading with their eyes for her to just stop talking. Maybe she picks up the exhausted vibes, because she spends the first twenty minutes rambling absentmindedly: She says "actions speak louder than words" and "Morvillo can't read Faneuil's mind—you are the ones who must decide what Faneuil was thinking about." That advice should knock a day off deliberations.

She repeats the same stuff Schachter said in his closing, only simplified to the point of uselessness. "Faneuil did accept responsibility—he turned himself in!" she pleads. The jury just looks at her—no one's taking notes. "He accepts that he lied before, he admits it, he accepts responsibility. He even volunteered that he misrepresented his GPA on his resume, claiming 4.5 when in fact he had a 4.44."

It's all downhill from there, if you can imagine. "Faneuil was tired by day three up there on the stand. He'd been through a huge ordeal. He's not going to be totally consistent." Even worse, she attempts to rebut accusations that Faneuil exaggerated and twisted conversations to fit his needs by unintentionally calling him a good actor. "Remember how he represents his boss from the January 13 SEC tape—didn't his [imitation] sound just like Bacanovic?" It' probably doesn't work to Faneuil's advantage that he's a good impersonator.

She closes with another flub, the most telling one of all. "Morvillo suggests that Peter and Martha were too smart to make the mistakes they made. But white collar criminals are often bright and do really stupid things—perhaps the two were dismissive or arrogant about the investigation, perhaps they didn't take it seriously..." And perhaps the government was looking for an excuse to take down corporate America. For being too successful, and too damn proud.

Tomorrow Cedarbaum will read the jury her 70-page long list of instructions.

Golden Slumbers

info@reason.com (Elizabeth Koch) — Mon, 01 Mar 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

Martha Stewart has some problems getting through the courthouse metal detector today. I'm waiting a yard or so away, but I swear on her third beeped walk-through a male member of her clan quips, "What's up with that, Martha? Didn't they drop the securities charge?" She shrugs and laughs.

Judge Miriam Cedarbaum may have thrown out the securities fraud count last Friday, but this morning Prosecutor Karen Seymour argues that the government should be allowed to redefine the charge in the "other lies" category. Cedarbaum will permit prosecution to argue that Stewart's June 12 and 18 public statements, in which she refers to the "$60 agreement" between Martha's broker, Peter Bacanovic, and herself, were attempts to mislead the public but not to defraud her investors.

While the jurors shuffle in and settle into their seats, Cedarbaum instructs them "not to speculate as to why the securities fraud charge was thrown out. That fact should not enter out deliberation." It will be interesting to see how and if Morvillo slips his small victory into his closing arguments.

Other than a few embarrassing attempts at mimicry, United States Assistant Attorney Michael Schachter offers a persuasive closing. He manages to thread together enough loose ends—a colorful array of surmises and speculations—into what appears to be a tightly knit red flag. Sitting in the courtroom today, it's easy to see how one could buy his whole story and only later, when forced to look closely, notice the holes.

Schachter centers the greater portion of his closing arguments on the testimony of Douglas Faneuil. He repeats Faneuil's argument that Peter bullied him into swallowing multiple cover ups with regards to Stewart's dumping her ImClone shares—first to a tax-loss agreement, then a $60 floor agreement. Schachter says, "Use your common sense, ladies and gentlemen. Why on earth would anyone make this up? There had been no subpoenas; Faneuil came forward on his own. It was his word against two powerful people. He admitted to lying in two interviews, had his personal life exposed, and is barred from working in the securities field for life." Schachter calls upon common sense a lot, and Bacanovic attorney Richard Strassberg will later do the same. If participants in this trial had been using common sense, we wouldn't be here. Peter would not have let his assistant of six months handle the trade, Martha would not have lied about calling Sam Waksal minutes after selling her shares, and Faneuil wouldn't have blamed everyone around him for what were ultimately his poor decisions. The prosecution would not have a case. Request anything you want—the weighing of facts, attention to omissions and inconsistencies, proof beyond reasonable doubt. But to incite common sense is like saying, "go with your gut." Which may be a fine guide for buying prom dresses or booking hotels in Bermuda, but not when concluding innocence or guilt.

The jurors, who appeared ready to applaud after Seymour's opening, now seem balanced and thoughtful, if not a bit skeptical. Most keep their heads cocked in question, many take notes. None look convinced.

"You are going to hear," Schachter says, curling his lip in preparation for Round One of imitations, "that Faneuil was 'fixated' on Stewart. But is there a shred of evidence to support this? A couple of e-mails? Does anyone really believe that because Martha was mean to him during a couple October phone conversations, that Faneuil would make up this whole scheme just to get her back? That he would do anything to be the 'big man'?" He tosses his head from side to side, pitching his voice like a grade-schooler singing "nanny nanny boo boo." No response from the jury. As for Martha, she has yet to move.

Schachter recalls Emily Perret, Sam Waksal's assistant in 2001, who testified that Martha called the office on Dec 27 and demanded to speak to Sam. "Martha Stewart testified to the SEC that she was just calling to see how Sam was. But ladies and gentlemen, does 'Get Sam! I want to know what's going on!' sound like a condolence call?" Imitation Round 2. Is Schachter's copying his star witness' courtroom shtick? The attorney's method is more than reminiscent of Faneuil's testimony, where the assistant seemed to draw true pleasure from doing Martha impersonations. Call me a type caster, but I'd say the style is better suited to a twenty-eight year old pretty-boy club kid than the Assistant U.S. Attorney. After saying the burden of proof rests on the government, Schachter qualifies, "But if you believe Faneuil's testimony, the trial is over. You can go home early."

Schachter uses the complementary statements of Zeva Bellel and Eden Werring to further explore his comedic urges, this time to better affect. Faneuil's two friends both testified that he'd confided in them about the events of December 27, specifically that his boss had directed him to tell Martha Stewart that Sam Waksal was selling, then cover it up. The attorney rightfully asked why on earth he'd lie to them too. "Faneuil wasn't trying to cut a deal with Zeva. He was not trying to get a cooperation agreement with Eden. Why tell them at all, when any admission would only create new witnesses to the fact that he was lying to the SEC? The only reason he'd tell them was [to get it off his chest.] To tell the truth."

Juror 3 scribbles furiously. Martha looks at her lap.

As for Seymour, when her eyes aren't performing witchcraft on the jury, she sneaks little glances at the press box, makes an assessment, than returns her gaze to the jury. Her rebut will follow the defense's closing arguments.

After we all endured two days of ink wars, Schachter spends about ten seconds discussing the "second pen" Bacanovic used to write @ $60 on the document in question. Instead, he focuses on the illogic of the agreement: That ImClone had fallen the same amount on the 21st of December as on the 27th. "Mr. Maine, [a market analyst] would have you believe that on December 27, ImClone was 'falling out of bed.' I submit that if ImClone had really been 'massacred' the way he said it had, we'd be in another Great Depression." Juror 4 laughs. Number three frowns and clutches his head, scribbling more furiously.

Finally Schachter gets to Heidi Deluca, Stewart's business manager. If anything was massacred, it was her testimony on Schachter's cross. "Heidi points to a note she purports to have written on Wednesday, November 8, as proof of the $60 agreement. I submit she was confused, that she actually wrote down "tender offer" and "ImClone—$61.52" on Wednesday, October 24." He asks if it was mere coincidence that the stock price hit that exact amount during her October conversation with Peter, when they were discussing selling the ImClone shares in Martha's pension funds. Or that the stock price never actually hit $61.52 on November 7 as Heidi purports. Or that said tender offer expired on October 26, the day before Peter sold Martha's pension shares at around $61. "What was Heidi Deluca doing up there on the stand?" Indeed.

Defense lawyer Richard Strassberg, like Schachter, dwells on Faneuil for the greater portion of his closing. Once, that is, he gets off the dead-end argument that "it makes no sense that Peter Bacanovic, who had built his whole life on his integrity, whose entire career depends on his clients' trust, would have told his assistant of six months to betray another client and pass along personal info. Celebrities especially want to guard their stock—if he'd told Martha Stewart about another client's activities, how could she ever trust him again?" Fine, Strassberg, it makes no sense. But Peter's human. He could have done it anyway. Next.

The judge falls asleep about here. Juror 11 quickly follows, head lolling so far to the right she'll shortly be in her neighbor's lap.

Strassberg's arguments are most effective when he explores Faneuil's integrity. "Faneuil had a motive to lie from the very beginning. He knew that telling Martha about Waksal's stock activity was wrong—he testified to that. He knew what the company policy was. He knew he could get into trouble, so he balked and blamed it all on Peter. Faneuil refuses to take responsibility for what ultimately was his decision." And this issue—that of personal responsibility—is the crux of Strassberg's argument.

To paraphrase, Strassberg says, "Faneuil admits Peter never told him to lie, but tries to minimize his own culpability by repeating that his boss aggressively implied he should. That in affect, Bacanovic bullied and intimidated him into agreeing with his stories. Faneuil paints himself the victim throughout his testimony, suggesting, 'Not my fault, I didn't know better'—even softball issues. Like when he didn't have the correct brokerage registration, when he threw away Eliza Waksal's stock sale stub, when he tossed a fax sent by a Waksal representative. It's always someone else's fault. He testified that although he knew what Bacanovic reportedly told him to do was wrong, he figured boss knows best." Cedarbaum's eyelids flutter—has she revived? No, there they go again. Strassberg is not deterred, probably because his back is to her. "Which is exactly what he says when his lawyer, the late Jeremiah Gutman (who died of a heart attack days after his testimony), inferred he should either lie to the SEC or say nothing. 'I figured my lawyer was looking out for me.'"

"Now Faneuil's a fascinating character—he twists the facts in just the key way to make all the difference in the world." Juror 11 jolts awake, notices her new friends are all bent over their notebooks, and follows suit. Strassberg continues, "Now Mr. Gutman testified to something a little different than what Faneuil said; Gutman's statement is that he told Faneuil to tell the truth or take the fifth, not to continue lying."

By this time, even Martha's spirits have visibly risen. She's watching the jurors with confidence and interest. They're too focused to notice.

"Faneuil's got enough conspiracy theories to go around. He accused Marcus, the head Merrill Lynch compliance officer, of telling everyone to keep quiet. He accused Judy Moynihan, a Merrill Lynch administrative officer, of bribing him, retracting only after realizing how ridiculous it sounded. Now is Faneuil just misunderstanding, or is he making this up?" Juror 4 taps his hands on his lips, nodding slightly. "If he just misunderstands, why do all the misunderstandings work out in his favor?"

Good question. Toward the end of the day, Strassberg asks the jury to consider whether the demeanor we saw on the stand—that of a confident witness evidently able to look folks in the face and lie, as he did with the SEC on several occasions, who resists answering direct questions over 200 times in exchange for asserting his own version of events, who always has to get in last word—"Is that someone who seems too timid to ask Peter Bacanovic a question about his story? Is that aggressive, astute person the one we heard him describing back in 2001? Those to people are not the same."

When Cedarbaum wakes up, she tells Strassberg to wrap it up. He can take another 45 minutes tomorrow. Robert Morvillo's closing, if anything like his defense tactics thus far, will likely be brief.

Defense Plays Dead

info@reason.com (Elizabeth Koch) — Wed, 25 Feb 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

Judge Miriam Cedarbaum begins the day with a promise: "We're very close to home plate, members of the jury." She rushes the attorneys through their remaining evidential requests before calling the final defense witness to the stand. Steven Pearl, an attorney who accompanied Stewart and John Savarese—Martha's corporate lawyer in 2002—to the February 4 SEC interview, is Martha Stewart's one and only witness. It seems Stewart's attorney, Robert Morvillo, assumes the single witness strategy is its own evidence, as if the prosecution's case is so paltry Martha's got nothing to prove. The tactic seems risky, especially considering the two strongest testimonies—that of Doug Faneuil and Heidi Deluca—both wounded the defense.

The jury may feel shortchanged.

Witness: Steven Pearl, a private attorney assigned to take notes during Martha Stewart's February 4, 2002 statement to the FBI and SEC. Pearl accompanied Stewart and John Savarese to the meeting

Prosecution contends that during the interview, Stewart falsely claimed she didn't know whether a record existed of the message Bacanovic left her on December 27. Since the FBI rarely tapes interviews—a practice that should itself raise eyebrows—Pearl's notes are Stewart's best weapon against the false claim charge. The neophyte lawyer testifies that his transcription "captures the substance of the interview, and some of the details, but is not a verbatim account."

"Did you record your notes in a database, Mr. Pearl?" asks defense attorney John Tigue.

"Yes, I typed them up in a memorandum, which I completed in full the following day—February 5, 2002." He says the memorandum is more comprehensive than the notes, since he was able to recall names and other details after the interview concluded.

Pearl seriously over-lawyers himself. When Tigue asks the witness if he remembers the question, "What time did Peter leave you a message on December 27, Ms. Stewart?" Pearl hems and haws and mutters about word precision, then finally admits to somewhat recalling the question but not Stewart's answer. He's more certain that John Savarese offered to look up the message in Martha's log.

Predictably, Pearl is even more hesitant on cross. Assistant U.S. Prosecuting Attorney Karen Seymour swanks herself up to the podium, flaring her dimples like she knows she's got him. Her first series of questions establish that Pearl's no note-taking expert, a fact he readily agrees to. She then enters into evidence the disputed portion of his records, comparing a line from Pearl's notes to a line from the memorandum:

Notes:

Q: When did Peter call?

A: —— log that Peter carried?

Memorandum:

AUSA: At what time had PB left a message for MS to call him on December 27?

MS: Does not know. JFS to send them the phone log.

Seymour's goal is to punch holes in Pearl's accounts: if the jury believes that the question posed to Martha concerns the time of Peter's message rather than its general existence, the government's false statement charge turns to dust. She riddles Pearl with queries: did he record every question; is he certain of Martha's response; how could he possibly piece anything together at this late a date. He concedes her every point. Wimp.

Seymour, seeing he's an easy target, hits harder: "Mr. Pearl, regarding the question mark that follows '...Get phone log Peter carried.' Couldn't it mean there was some question about the existence of a phone log?" Pearl seems skeptical, but doesn't disagree. "Isn't it true that you don't know who suggested that Savarese 'get the phone log'?"

He hesitates, then grants that as well.

"Is it fair to say that today, based on these notes, you don't know if Ms. Stewart knew the phone message existed?"

Pearl starts to speak, pauses to reflect, then concedes. "I'm not sure." Not a stellar testimony, but you never know: Te young lawyer's triple-time deliberations could work to the defense's advantage. If he's that nitpicky on the stand, the jury might conclude he attended to his memorandum with the same diligence.

Witness recall: Larry Stewart, the Secret Service's chief forensic scientist. National ink expert

Two days ago, when Larry Stewart's rival and one-time boss, Dr. Albert Lyter, testified for the defense, Stewart was there to watch. The self-proclaimed ink king sat with folded arms while Lyter explained the results of his densitometer testing, sighing and rolling his eyes when Lyter concluded that at least three pens were used on Bacanovic's "@60" document. And here he is, back on the stand, all geared up to rebut. "The numbers Lyter generated don't make sense," he gripes. "When I tried to recreate his results, I found that if I manipulated the machine, shaking it and twisting it around, I could get the numbers to turn out any way I wanted." Is the mudslinging really necessary? It's hard to believe this guy's testimony is built on much more than ego.

In the end, Larry Stewart is forced to testify that although in his estimate only two kinds of ink appear on the page, it's possible the circles and checks came from multiple Bics. My conclusion certainly hasn't changed: the ink war is bogus. The fact that Bacanovic used more than one pen, like most mortals, is hardly the crucial evidence. If Cedarbaum's opinion is any indication, it's unlikely the jury will lean too heavily on either "expert" testimony—"Are we still on the ink?" she grouses after lunch.

The most damning evidence of the day comes last, in the form of an audiotape. Prosecution plays a few minutes of Bacanovic's February 14 interview with the SEC, the thrust of it concerning the content of Peter's conversations with Martha's Connecticut office business manager, Heidi Deluca. Bacanovic begins with a denial: "I would only speak of [Stewart] buying or selling securities in the context of tax planning." Not a contradiction: Yesterday Deluca testified that the $60 agreement came up during a discussion about tax-loss selling.

"Did you speak with [Heidi] about Martha Stewart selling ImClone stock?" the interviewer asks.

Peter explains the context in which ImClone came up. He says Deluca was frustrated they'd sold ImClone at a gain at the tail end of 2001. "She didn't expect me to add gains at the end of the year," he says, which again parallels Heidi's testimony.

The interviewer persists: "So she was wondering why you'd put in a gain right before the end of the year?"

"Correct," Bacanovic says. "And I told her what I tell all my clients: 'Gains are good.'"

When the interviewer gets to the $60 question, things take a wrong turn. "Did you talk to Heidi at all about, you know—once the stock hit $60, [Stewart] should sell?"

"I don't go into that level of detail with Heidi," he insists.

"And she never brought it up to you?"

"No. She only brought it up to me in terms of adding gains to the account," Bacanovic's on record as saying. "She made a short passing comment, 'Oh, you've added gains. Why did you add gains to the account? I thought we had the whole thing so tidy.'"

But yesterday, Heidi testified that she and Peter did speak specifically about getting rid of the ImClone shares in Stewart's personal account. Deluca's statement was that on November 8, 2004, "Peter said ImClone was a dog, and that once Martha's personal account was transferred from Morgan Stanley to Merrill Lynch, he'd suggest setting a $60 floor on ImClone." Either Peter didn't remember relaying the message to Heidi or he was lying. Jury's call.

The charge conference, where Cedarbaum debates her jury instructions with the attorneys, takes place tomorrow. Press may or may not have access to the transcript; we'll know by 5:00 p.m. Closing arguments are Monday and Tuesday. Cedarbaum may hold off her securities charge ruling until after the verdict.

Heidi Boils

info@reason.com (Elizabeth Koch) — Tue, 24 Feb 2004 00:00:00 EST

These are Elizabeth Koch's notes on the Martha Stewart trial.

Theoretically, Judge Cedarbaum made her hearsay rulings this morning; in practice, they had little to do with Heidi Deluca, Martha's Connecticut office administrative business manager, and everything to do with defense attorney David Apfel. The judge did not rule in his favor.

Apfel does his best to question Deluca, but can hardly cough up two words without Cedarbaum blasting him. He asks about Stewart's money transfers: "You cannot lead the witness!" About Heidi's part in the January 3, '03 phone conversation with Doug Faneuil: "I already ruled on that!" About an e-mail Deluca received from Marylin McCallister, an outside accountant, in the beginning of January. "Mr. Apfel, I don't know why you can't abide by what I rule." About anything and everything in between: "Will you just ask the question?"

All of this in the first 10 minutes. The jury looks embarrassed, the press bench holds its collective breath, I have an empathetic panic attack. Apfel, trooper that he is, just keeps on going.

And apparently commits a major blunder, that doesn't make itself known until prosecuting attorney Michael Schachter's cross.

The first part of Deluca's testimony goes much like yesterday, with Heidi now testifying in front of the jury. Apfel asks her about an ImClone conversation that took place between she and Stewart on January 29, 2002.

"Martha asked me, 'What do you remember about ImClone?'" DeLuca says. "I reminded her that ImClone was part of her pension plan, that she tendered shares out of her personal account, and that Peter said he'd talk to her about setting a price bottom of $60 or $61."

So far so good. Just wait.

Michael Schachter has never looked so good. "I've never seen a better cross," a veteran court reporter and legal expert announces at lunch today. Schachter reels Deluca in with a seemingly innocent question about her job requirements. She happily answers.

He continues, "About what percent of you workday do you spend on Martha Stewart Living Omnimedia, and what percent for Ms. Stewart's residential services?"

"I'd say 30 percent MSLO, and 70 percent personal."

"Who pays you?"

"MSLO," she blinks without a thought.

"In full?" he reiterates.

"In full." Advice on how to burn a frog suddenly pops in my head. You start out with the temperature on low, so it's sitting all warm and comfy, and slowly turn up the flame.

Deluca testifies that as of late October 2001, Stewart had 51,800 ImClone shares in her Merrill Lynch pension account, and 5000 ImClone shares in her Morgan Stanley personal account. Heidi insists that on November 8, 2001, she spoke with Peter Bacanovic on the phone about the ImClone stock Martha held in her personal account at Morgan Stanley. Deluca testifies that although Peter thought ImClone "was a dog," he said he'd talk to Martha about setting a floor price at $60 or $61—"when her Morgan Stanley shares arrived at Merrill Lynch."

Schachter: "About Ms. Stewart's pension account—tell us again how many ImClone shares she had there?"

"51,800."

"When were those sold, and for how much?"

"In late October 2001, for around $61," Heidi recalls.

"Isn't is possible, Ms. Deluca, that the Nov 8 conversation you remember actually took place on October 24, '01, the day before Ms. Stewart sold the stock in her pension account? Didn't the $60 conversation you had with Peter refer to her pension plan and not her personal account?"

She blinks, this time thinking. "Will you repeat the question?" she asks, a request she'll make of Schachter more than once. And not because he's being unclear. Quite the opposite. He's polite, considerate, and almost humble throughout his cross. No one objects, no one stirs.

"No. I had several conversations with Peter about ImClone. The one in October was about the pension plan; the one in November was about Martha's personal account," she insists.

"And how are you so certain, Ms. Deluca?"

"I know we spoke about the $60 or $61 floor on November 8 because I'd checked on the price the day before—I was regularly checking up on ImClone's price—to see if it had gotten closer to the tender offer. I recorded the price at $61.52 on November 7 and asked Peter about it the next day. He said he'd speak to Martha personally."

"Did you talk to Stewart about the $60 floor? Did you follow up with her regarding ImClone's stock price? Did you ever warn her when the price hit $60 and then dipped below as it did several times between November 8-12?" Schachter asks.

"No, it was taken out of my hands at that point [i.e., after her November 8 conversation with Peter]. Peter said he'd take it up with Martha."

Unfortunately for the defense, Schachter enters into evidence Heidi's message log. On a note dated October 25, 01, 2001, the day the pension shares were sold at $61, Heidi writes: "I know Martha wants me to stay out of it, but I wanted to remind her one last time of the 5000 ImClone shares in her Morgan Stanley account. Now it's out of my hands." This admission makes Heidi look perilously confused. Basically, she claims haphazardly that events which occurred on October 25 actually took place on November 8, and further muddles matters by attributing dates and conversations to activity in Martha's personal account when they can more logically be connected to her pension account. As we'll continue to see.

Schachter remains patient and focused as he simmers the defense witness. He asks about Martha's MSLO stock sale on October 24, 01, insinuating that Deluca spoke to Bacanovic on the phone on October 24, '01, at 2:19 p.m. for 21 minutes, about Martha's tax-loss selling plan, about which stocks to sell at a loss to offset her MSLO gains. He enters into evidence the Quicken worksheet on which Heidi noted Peter's suggestions, as well as the e-mail Deluca sent Stewart October 25, 2001, the following day, filling her in on Bacanovic's suggestions.

On a document also dated October 24, 2001, a document listing the same stock with the same prices as the e-mail Heidi sent Martha on October 25, Heidi scrawls at the bottom, "Wednesday. Im-Clone: $61.52. Tender offer not responding." This is the note Heidi claims to have written on November 8, 2001. But once again, the document is dated October 24, not November 8. It's baffling how defense missed this, and more baffling that no one asks Heidi why on November 8 she wrote such a note on a seemingly unrelated document, one dated two weeks prior to her claim. There are feasible explanations—mine would be complete guesses—but the fact that defense doesn't take this one on isn't a good sign. Schachter does: he believes Deluca's note was referencing a tender offer Bristol Meyers made on September 28, 2001, a bid to buy 20 percent of ImClone shares @ $70. By "tender offer not responding," Heidi—the prosecution contends—must have been comparing the $61.52 price she recorded off NASDAQ to the $70 Bristol Meyers was offering.

And to sum up the coincidences, bringing Heidi to a full boil: Bristol Meyer's tender offer expired at 5:00 p.m. on October 26, 2001, just two days after Heidi's phone conversation with Peter. Schachter enters phone logs into evidence that record a 10 a.m. phone call Peter made to Heidi on October 25. "Isn't it true that Peter called you on October 25 because he wanted Martha to tender the ImClone stock in her pension account at $61?" Schachter asks again.

"No, I recall something different about the conversation." Schachter, of course, doesn't give her an opportunity to share. It's hard to argue with the facts: During the 21 minutes Peter and Heidi communicated in October 24, 2001, ImClone hit $61.52. Martha sold the shares in her pension account on October 25 and 26, at almost exactly that price.

On redirect, the only thing defense lawyer John Tigue gets out of Deluca is that Stewart reimbursed MSLO for Deluca's salary in '02.

The only other witness of the day is John DeMaine, a retired stock broker. He now acts as an independent consultant and has testified in over 300 trials. Today he demonstrates the extreme volatility of ImClone on December 27, claiming the stock "fell out of bed" immediately after NASDAQ opened. Even as the volume of stocks fell in the market at large—an event you'd expect during the Christmas holidays, he testifies—ImClone's volume spikes, as early as 9:30 a.m. He says target pricing makes sense with an unstable stock like ImClone. Defense seems to be using DeMaine's testimony to recall Bacanovic's assistant, Doug Faneuil, who also testified about ImClone's December 27 activity. In his statement, Faneuil quoted Bacanovic as shrieking into his cell, "Oh my God, the stock is going crazy, get Martha on the phone," a statement consistent with DeMaine's observations. Take it a step further, and we recall the message Faneuil left Martha's assistant, Amy Armstrong, on December 27, 2001, which said, "Peter Bacanovic says ImClone is selling downward." Which it was, at an alarming rate. Even if Martha did erase then put back the message, one could easily make the case that she knew how such a note could be interpreted. And it turns out she was right.

Bacanovic's defense team rests. Robert Morvillo is calling one witness to testify on Stewart's behalf: Martha's MSLO attorney, the one who actually took notes during her Feb 4, 2002 interview with the SEC.

Prediction: Both parties will rest tomorrow; Cedarbaum will hold the charge conference on Thursday; and closing arguments will be Monday and Tuesday.

Cedarbaum has yet to rule on which charges, if any, she'll drop.